Invesco Shuns Asian Bonds as Fed Tightening Keeps UBS Asset Away

  • Rise in bond yields capped by slower growth, inflation in Asia
  • Fed tightening gives Asia less room to ease on outflow risk

Invesco Ltd. and UBS Asset Management aren’t adding to their holdings of Asian local-currency sovereign bonds for the time being as they see yields in most markets rising in tandem with U.S. Treasuries.

Five-year U.S. yields climbed to a six-month high overnight after the Federal Reserve raised benchmark rates for the first time in almost a decade and projected four more increases in 2016. The reaction in Asian markets, which was fairly muted on Thursday, is likely to be limited by the impact of China’s slowdown that’s acting as a drag on the region, the asset managers say.

"Asian government bonds will get caught to some extent with what’s going to happen to Treasuries and whether the market has to adjust prices to move closer to the Fed," said Ashley Perrott, the Singapore-based head of Asian fixed-income at UBS Asset, which oversaw $652 billion at the end of September. "But given Asian central banks don’t appear to be in any position to tighten policy and keep up with the Fed, I wouldn’t think you’re going to see much upward pressure on Asian yields."

UBS Asset still sees opportunities in India, South Korea and Indonesia on falling inflation, Perrott said. Invesco isn’t looking to add to Asian domestic debt holdings except in China, said Ken Hu, chief investment officer for Asia Pacific fixed income in Hong Kong.

"Most Asian countries’ local-currency government bond yields will tend to rise because historically Asian countries have a very high correlation with U.S. Treasury yields,” said Hu. “But because China is a big economy and it has an independent monetary policy it’s running a very different interest-rate cycle than the U.S.”

Currency Risk

Fed officials forecast borrowing costs will rise to 1.375 percent by the end of 2016, implying four 0.25 percentage point moves. The two-year U.S. Treasury yield will jump 70 basis points to 1.7 percent by end-2016, while the 10-year yield will rise 49 basis points to 2.75 percent, according to the median estimates in a Bloomberg survey of analysts.

With the U.S. embarking on a tightening path, Asian central banks have less room to ease monetary policy as it would further erode the yield advantage they enjoy over the U.S. and risk capital outflows. A gauge of Asian currencies has fallen 5.7 percent this year, headed for the biggest drop since 2008, and the region’s exchange rates are forecast to come under further pressure in 2016.

"If they ease in this environment, it does risk currency depreciation getting a bit disorderly," said UBS Asset’s Perrott. "With Fed tightening, it might also mean they don’t have to ease and they can allow the currency to do the easing for them."

Average yields on Asian credit will rise more slowly than the Fed funds rate, Joel Kim, the head of Asia-Pacific fixed income at BlackRock Inc. in Singapore, wrote in a research note on Thursday. The fund manager said the region’s debt would continue to deliver “solid positive returns” in 2016.

"We still expect quite high correlation between U.S. and Asian yields unless Asian countries shift their currency anchor from the U.S. dollar to the yuan," said Invesco’s Hu. "In the next one or two quarters Asian local-currency government bond yields may tend to follow U.S. levels, but by the middle of next year, deflationary forces will get stronger and bond yields may come back down."

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